8.13 Price controls
We know that total surplus is maximized at the market-clearing price. But governments may nevertheless decide to intervene in a market to change the price to achieve other objectives, such as fairness.
In some countries, local or national governments control housing rents. Sometimes this is to protect tenants, who may have little bargaining power in their relationships with landlords, or sometimes because urban rents would be too high for groups of workers who provide essential local services.
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Figure 8.25 shows a situation in which the local government might decide to control the housing rent in a city. (Note that here we mean rent in the everyday sense of a payment from tenant to landlord for the use of accommodation.) Initially, the market is in equilibrium with 8,000 tenancies at a rent of €500. Now suppose that there is an increase in demand for tenancies. Rents will rise, because the supply of rental housing is inelastic, at least in the short run: it would take time to build new houses, so more tenancies can only be supplied immediately if some owner-occupiers decide to become landlords and live elsewhere themselves.
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rent ceilingThe maximum legal price a landlord can charge for a rent.
Suppose that the city authorities are concerned that this rise would be unaffordable for many families, so they impose a rent ceiling at €500. Follow the steps in Figure 8.25 to analyse what happens.
In general, a controlled price will not clear the market, and trade will then take place on the short side of the market: that is, the quantity traded will be whichever is lower of the quantities supplied and demanded. In Figure 8.25, the price is low and suppliers are on the short side.
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When the rent is €500, the number of tenancies will be 8,000. Of the 12,000 people on the long side of the market, 8,000 would pay €1,100 or more, but tenancies are not allocated to those with highest willingness to pay. Those lucky enough to obtain tenancies may be anywhere on the new demand curve above €500.
The rent control policy puts more weight on maintaining a rent that is seen to be fair and affordable (by existing tenants who might otherwise be forced to move out), than it does on Pareto efficiency. The scarcity of rental accommodation gives rise to a potential economic rent: if it were legal (it usually isn’t), some tenants could sublet their accommodation for €1,100, obtaining an economic rent of €600.
If the increase in demand proves to be permanent, the long-run solution for the city authorities may be policies that encourage housebuilding, which shifts out the supply curve so that more tenancies are available at a reasonable rent.
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